Journal of Economics and Financial Analysis, Vol:4, No:1 (2020) 1-14

Journal of Economics and Financial Analysis

Type: Double Blind Peer Reviewed Scientific Journal
Printed ISSN: 2521-6627 | Online ISSN: 2521-6619
Publisher: Tripal Publishing House | DOI:10.1991/jefa.v4i1.a30
Received: 16.05.2020 | Accepted: 01.08.2020 | Published: 28.08.2020
Journal homepage: ojs.tripaledu.com/jefa

Trade Liberalization and International Trade: A Case Study of

China
Adel Shakeeb MOHSEN *
British Institute of Management and Technology, Ivory Coast

Abstract
This study investigates the effect of trade liberalization on international trade in
China over the period 1980-2018. Trade openness is used as an indicator of trade
liberalization. Unit root test, cointegration test, Granger causality tests, and IRFs
were used in this study. The cointegration test shows that trade openness has a
positive effect on exports and imports. Trade openness has a greater effect on
exports than imports. Besides, export and import are positively related to gross
fixed capital formation and inflation, but negatively related to oil price.
Furthermore, the Granger causality test indicates that there are bidirectional
short- and long-run causality relationships between trade openness and exports,
and also between trade openness and imports.

Keywords: Trade Liberalization; China; Cointegration; Causality Test; Trade

Openness.
JEL Classification: B17, C33, F00, F21.

*
Corresponding author. Abidjan, Ivory Coast.
E-mail: adelmhsen@hotmail.com

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1. Introduction
China has the second largest economy in the world by nominal GDP, and the
fastest economic growth rate in the world over 30 years until 2015 (Schwartz and
Abrams, 2015). Besides, China is the largest manufacturing economy, the fastest
growing consumer market, and the largest exporter of goods in the world. It also
plays a vital role in international trade, and has the second place as the largest
importer of goods in the world (Barnett, 2013).
Since the late 1970s, China has started in reforming its economy to integrate
itself into the international trade system. Import and export growth has continued
to be one of the major supporters of China's rapid economic growth. Therefore,
China worked on improving the quality and quantity of its production, enhancing
the investment, and liberalizing its foreign trade. Besides, it has signed free trade
agreements with many countries like ASEAN, Pakistan, Australia, South Korea,
New Zealand, and Switzerland. It also joined the Asia-Pacific Economic
Cooperation (APEC) group in November 1991, and the WTO in December 2001,
after 16 years of negotiations (Chen et al., 2015).The biggest percentage share of
imports in china consists of capital goods, industrial supplies, and high-technology
equipment. The majority of these imports come from developed countries like
Japan and the United States. On the other hand, China exports agricultural
products, chemicals, and manufactured goods such as electronic equipment and
textiles, which consist the biggest percentage share of the total exports in the
country.
The main objective of this study is to investigate the effect of trade
liberalization on international trade in China over the period 1980-2018. The
organization of this study is as follows. The next section is the literature review,
the third section provides a brief discussion on the methodology, and the fourth
section reports the empirical results and the conclusion are presented in the last
section.

2. Previous Studies
A large number of studies investigated the effects of trade liberalization on
trade flows. Most of these studies including Santos-Paulino and Thirlwall (2004),
Wu and Zeng (2008), Allaro (2012), Hoque and Yusop (2012), Chaudhary and Amin
(2012), Kassim (2013), Zakaria (2014) and Sofjan (2017) concluded that trade
openness has a positive effect on both exports and imports. Besides, Weiss
(1992), Thomaset al. (1991), Helleiner (1994), Joshi and Little (1996), Jenkins

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 A.S. Mohsen / JEFA Vol:4 No:1 (2020) 1-14

(1996), Bleaney (1999), Ahmed (2000), Edwards and Alves (2006), Ju et al. (2010),
Anwar et al. (2010), Cestepeet al. (2015), Ofei (2018) and Osakwe et al. (2018)
found that exportsare affected positively from trade liberalization. Melo and Vogt
(1984), Bertola and Faini (1991), Mah (1999), Santos-Paulino and Thirlwall (2004),
Wu and Zeng (2008), Ju et al. (2010), Fatukasi and Awomuse (2011), Allaro (2012),
Hoque and Yusop (2012) and Armah et al. (2014) concluded that trade openness
has a positive effect on imports.
On the other hand, there are other studies tested the effects of other factors
such as oil price, investment, GDP, consumption and inflation on exports and
imports of different countries. Enimola (2011) found that there are positive
relationships between exports and GDP, real exchange rate, FDI and external
market access indicator in Nigeria. Mohammad’s study (2010) revealed that GDP,
living standard and balance of trade affect exports positively in Pakistan, but high
oil price causes a rise in inflation, which affects exports negatively. Moreover,
Elhiraika and Mbate (2014) studied the long-run determinants of export
diversification for 53 African countries, and concluded that the per capita income,
infrastructure, public investment, human capital and the institutional framework
are significant drivers of export diversification and transformation. Karamuriro
and Karukuza (2015) detected that the GDP of Uganda, GDP of the importer's
countries, GDP per capita, and exchange rates have a positive effect on Uganda’s
exports flow. Abidin et al. (2016) found that the size of the economies,
population, rates of exchange bilateral distance are the determinants of Malaysia-
ASEAN exports. Abidin and Haseeb (2017) also found that bilateral distance,
exchange rates and GDP per capita are the determinants of the trade relationship
between Malaysia and GCC countries. Fochamnyo and Akame (2017) concluded
that trade openness, foreign aid, official exchange rates, FDI and gross domestic
investment promoted export diversification in SSA countries. Furthermore,
Osakwe et al. (2018) revealed that developing countries that are more open to
trade have more diversified exports structures comparing with countries that are
less open, and the human capital, GDP per capita and institutions play important
roles in exports diversification. Uysal and Mohamoud (2018), on another hand,
pointed out that GDP growth does not affect the export, while labor force, foreign
direct investment, industrialization, and exchange rate have a positive effect on
exports, but inflation has a negative effect on exports value of East Africa
countries. However, Agboola et al. (2018) concluded that export flow between
Malaysia-OIC countries in Africa are determined by distance, common colony,
GDP Per capita, GDP similarities, GDP, real exchange rates and population, but the
degree of openness of an economy was not significant.

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On the other hand, according to Egwaikhide (1999), foreign exchange

earnings, relative prices, and real income are significantly determining the total
imports in Nigeria. Bahamani and Kara (2003) also get the same result and
concluded that income has a significant influence on the import demand of nine
industrial countries. Narayan and Narayan (2005) and Joseph and Fosu (2006)
revealed that total consumption expenditure, export expenditure, and investment
expenditure affect positively the import demand of Fiji and Ghana, while an
increase in relative prices affects it negatively. Rahman’s (2009) study indicated
that inflation, GDP per capita and trade openness have positive effects on the
imports of Bangladesh, while the exchange rate has no effect on its imports.
Onwuka and Zoral (2009) also concluded that FDI, GDP, and domestic price (CPI)
have positive and significant effects on the import demand in Turkey. Besides,
Fatukasi and Awomuse (2011) found that GDP, real exchange rate and openness
affect positively import demand in Nigeria, while the level of external reserves
affects it negatively. However, Aljebrin and Ibrahim (2012) revealed that private
consumption, real income, international reserves, and gross capital formation
have positive and significant effects on the import demand of the GCC countries in
both the long and short run. Other studies including Narayan and Narayan (2006)
and Babatunde and Egwaikhide (2010) tested the impact of expenditure on
imports for diverse countries, and found that expenditure affects positively on
imports. Chani et al. (2011) obtained a positive and significant relationship
between import demand and all expenditure components for Pakistan. Vacu and
Odhiambo (2018) also found that import demand is positively determined by
trade liberalization, investment spending, and gross national income.

3. Methodology
The vector autoregression (VAR) model will be used in this study. In order to
investigate the effect of trade liberalization on the international trade in China,
two models will be used. The first model is the export model, which consists of
five variables, namely, exports, trade openness, oil price, gross fixed capital
formation, and inflation. Exports are the dependent variable. The second model is
the import model, and also it consists of five variables, namely, imports, trade
openness, oil price, gross fixed capital formation, and inflation. Imports are the
dependent variable. Trade openness is the indicator of the trade liberalization.
The export and import models are presented as follows:
ln(𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡 ) = 𝛽𝛽0 + 𝛽𝛽1 OPENt + 𝛽𝛽2 ln(𝑂𝑂𝑂𝑂𝑡𝑡 ) + 𝛽𝛽3 ln(𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 ) + 𝛽𝛽4 ln(𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡 ) + 𝜀𝜀𝑡𝑡 (1)
ln(𝐼𝐼𝐼𝐼𝐼𝐼𝑡𝑡 ) = 𝛽𝛽0 + 𝛽𝛽1 OPENt + 𝛽𝛽2 ln(𝑂𝑂𝑂𝑂𝑡𝑡 ) + 𝛽𝛽3 ln(𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 ) + 𝛽𝛽4 ln(𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡 ) + 𝜔𝜔𝑡𝑡 (2)

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where β0 is the intercept and β1, β2, β3 and β4 are the slope coefficients in the
export model, while β0 is the intercept and β1, β2, β3 and β4 are the slope
coefficients in the import model. The variable ln(EXP) is the natural log of exports;
ln(IMP) is the natural log of imports; OPEN is the trade openness as a percentage
of total exports and imports to GDP; ln(OP) is the natural log of oil price per
barrel; ln(GFCE) is the natural log of gross fixed capital formation; and ln(CPI) is
the natural log of consumer price index. Both εt and ωt are the error terms in
equations (1) and (2).
Annual time series data of China from1980 to 2018 are used in this study,
and the data were collected from the World Bank. The analysis will begin with the
unit root tests to determine whether the time series data are stationary at levels
or first difference. If the variables are integrated of the same order I(1), the
Johansen cointegration test will be used to determine whether there is any long-
run or equilibrium relationship between the dependent variable and the other
independent variables in the two models. If the variables are found to be
cointegrated, the Granger causality tests will be conducted based on the vector
error correction model (VECM) to determine the causality relationships among
the variables in the two models. However, if there is no cointegration relationship
among the variables, the VAR model will be employed to test for short-run
Granger causality between the variables. Lastly, impulse response functions (IRFs)
will be used to determine whether trade liberalization plays any important role in
explaining the variation of exports and imports at short and long forecasting
horizons.

4. Empirical Results and Discussion

The results of the ADF unit root tests show that all the variables in the two
models are not stationary at the level, but become stationary after first
differencing at least at the 5 percent level of significance. This means that all the
variables are integrated of order one, that is, I(1).

4.1. Johansen Cointegration Test Results

After determining that all the variables are integrated of order one, we can
run Johansen cointegration test to check if there is any cointegration or long-run
relationship among the variables in the two models. However, we should run the
VAR model first to determine the optimal lag length, based on the minimum
Akaike information criterion (AIC). The optimal lag length used in this study is four

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lags. Tables 1 and 2 below confirm that there is a long-run or cointegration

relationship between the variables in the two models.
After having found cointegration relationships among the variables in the
two models, the cointegration equations for exports and imports can be written
as:
ln(𝐸𝐸𝐸𝐸𝐸𝐸𝑡𝑡 ) = 0.1981 + 2.7445 ∗ OPENt + 0.1981 ∗ ln(𝑂𝑂𝑂𝑂𝑡𝑡 ) + 0.9293
∗ ln(𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 ) + 0.1981 ∗ ln(𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡 ) (1)
ln(𝐼𝐼𝐼𝐼𝐼𝐼𝑡𝑡 ) = 0.4773 + 1.8574 ∗ OPENt + 0.0221 ∗ ln(𝑂𝑂𝑂𝑂𝑡𝑡 ) + 0.9069
∗ ln(𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 ) + 0.1712 ∗ ln(𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡 ) (2)

Table 1. Johansen Cointegration Test Results for the Export Model

No. of CE(s) Trace Statistic Prob Max-Eigen Statistic Prob

r=0 321.3525*** 0.0001 178.7871*** 0.0001
r≤1 142.5654*** 0.0000 64.0767*** 0.0000
r≤2 78.4887*** 0.0000 34.7427*** 0.0006
r≤3 43.7461*** 0.0000 29.4322*** 0.0002
r≤4 14.3139*** 0.0049 14.3139*** 0.0049
Note: *** Denotes significance at the 1 percent level, and ** at the 5 percent level

Table 2. Johansen Cointegration Test Results for the Import Model

No. of CE(s) Trace Statistic Prob. Max-Eigen Statistic Prob.

r=0 284.5497*** 0.0000 109.2741*** 0.0000
r≤1 175.2757*** 0.0000 87.6688*** 0.0000
r≤2 87.6069*** 0.0000 44.0248*** 0.0000
r≤3 43.5821*** 0.0000 30.7722*** 0.0001
r≤4 12.8099*** 0.0098 12.8099*** 0.0098
Note: *** Denotes significance at the 1 percent level, and ** at the 5 percent level
It is clear from equations 3 and 4 above that trade openness has a positive
effect on exports and imports. This shows that the Chinese government's efforts
in liberalizing foreign trade have resulted in increased exports and imports. Trade

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liberalization enhances exports by reducing the restrictions on exports, cutting

export taxes, and simplifying the complex export procedures. Besides, it boosts
imports through facilitating import procedures and reducing import restrictions in
the country. Additionally, trade liberalization opens up new markets for Chinese
products, and motivates producers to improve and increase their production,
which in turn reflected positively on exports and imports in the country. Wu and
Zeng (2008), Chaudhary and Amin (2012), Kassim (2013), Zakaria (2014) and
Sofjan (2017) also argued that openness affects international trade positively.
However, it is clear that the oil price has a negative effect on exports and
imports. With increases in the oil price, cost of production will increase too, which
in turn drives producers to reduce their production. Also, when oil price increases,
the prices of foreign goods will be more expensive; this decreases the local
demand on it. Hence, the high oil price will reduce the total value of exports and
imports in the country. On the other hand, gross fixed capital formation has a
positive effect on exports and imports in China. An increase in the investments
requires from the producers to import more machines, production equipment,
raw materials and semi-finished materials that can be used in their production
activities. Besides, a rise in the investment will increase the production in the
country, thus leading to an increase in exports and imports. Furthermore, inflation
has a positive effect on exports and imports. When prices increase, firms will
produce more to increase their profits. Thus, inflation can be a reason that
motivates producers to increase their production. On the other hand, when the
local prices increase, the prices of foreign products will be less expensive; this
increases the local demand on foreign products. Hence, a rise in inflation
increases exports and imports in the country.

4.2. Granger Causality Test Results

Since the variables in the two models are cointegrated, the Granger causality
tests based on the VECM can be used to examine the short- and long-run causality
relationships among the variables in the two models. The results of the Granger
causality test are shown in Tables 3.
It is clear from Table 3 that there are bidirectional short-run causality
relationships between OPEN, lnGFCF and lnEXP, and unidirectional short-run
causality relationships running from lnOP and lnCPI to lnEXP. While in the long
run, there are bidirectional long-run causality relationships between OPEN, lnOP,
lnGFCF and lnEXP, and unidirectional long-run causality relationships running from
and lnCPI to lnEXP. On the other hand, there are bidirectional short-run causality
relationships between OPEN, lnOP, lnCPI and lnIMP, and unidirectional short-run

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causality relationship run¬ning from lnGFCF to lnIMP. Besides, there are

bidirectional long-run causality relationships between POEN, lnOP, lnGFCF, lnCPI,
and lnIMP. Hence, there are bidirectional short- and long-run causality
relationships between trade openness and exports, and also between trade
openness and imports.
Table 3. Granger Causality Test Results of the Export and Import Model
Dependent Independent variables in the Export model
variables ∑∆ lnEXP ∑∆ OPEN ∑∆ lnOP ∑∆ lnGFCF ∑∆ lnCPI ect(-1)

∆ lnEXP - 6.52 (3)** 5.83 (4)** 5.11 (4)** 8.18 (5)** -0.82**
∆ OPEN 4.37 (3)* - 2.43 (2) 4.51 (3)** 1.12 (2) -0.64*
∆ lnOP 1.47 (2) 5.01 (4)** - 3.34 (3)* 5.91(3)** -0.315*

∆ lnGFCF 3.17 (3)** 1.54 (2) 0.19 (2) - 2.12 (2)* -0.68**
∆ lnCPI 2.13 (2) 3.21 (3)** 2.08 (2)* 1.98 (2) - -0.21

Dependent Independent variables in the Import model

variables ∑∆ lnIMP ∑∆ OPEN ∑∆ lnOP ∑∆ lnGFCF ∑∆ lnCPI ect(-1)

∆ lnIMP - 7.32 (3)** 4.34 (3)** 4.12 (4)* 8.28 (2)* -0.42*
∆ OPEN 4.11 (3)** - 1.73 (2)* 3.71 (2)** 2.17 (2)* -0.62**

∆ lnOP 5.67 (3)* 3.01 (3)* - 2.21 (3) 3.12(4)** -0.85*

∆ lnGFCF 3.21 (2) 1.32 (4) 0.63 (2) - 3.13 (4)* -0.92**
∆ lnCPI 6.12 (5)** 3.32 (3)** 2.04 (2)* 5.61 (3)** - -0.65**
Notes: ect(-1) represents the error correction term lagged one period. The numbers in the
brackets show the optimal lag based on the AIC. ∆ represents the first difference. Only F-
statistics for the explanatory lagged variables in first differences are reported here. For the
ect(-1) the t-statistic is reported instead. ** denotes significance at the 5 percent level and
* indicates significance at the 10 percent level.

4.3. Impulse Response Functions

The IRFs are used to indicate the dynamic effects of a particular variable’s
shock on the other variables that are included in the same model, and to examine
the dynamic behavior of the time series over a 10-year forecast horizon. The

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generalized impulse response functions will be used in this study. It is clear from
Figure 1 that when there is a shock to OPEN, lnEXP and lnIMP will respond
positively in the following years. This reflects the important role that simplifying
import and export procedures can play in supporting exports and imports in the
country. Hence, trade liberalization has a vital role in boosting exports and
imports in China.

Figure 1. Generalized Impulse Response Functions for the Import and Export
Models

5. Conclusion
This study investigated the effect of trade liberalization on international
trade in China, using annual time series data from 1980 to 2018. Unit root test,
Johansen cointegration test, Granger causality tests, and IRFs were used in this
study. The results show that trade liberalization has a positive effect on exports
and imports in China. Hence, opening up China’s economy to international trade
was a good strategy that has been adopted by the government to boost exports
and imports of the country. Besides, the effect of trade openness on exports is
more than its effect on imports, which means that trade liberalization can play a
significant role in supporting the trade balance in the country. Hence, it is
necessary for the Chinese government to encourage investment and motivate
producers to improve the quality and quantity of their production.
The results also showed that export and import are positively related to gross
fixed capital formation and inflation, but negatively related to the oil price.
Furthermore, from the Granger causality tests, we found that there are
bidirectional short- and long-run causality relationships between trade openness
and exports, and also between trade openness and imports. Lastly, the impulse

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response functions indicated that exports and imports will respond positively to a
trade liberalization shock.

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